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Default risk in interest rate derivatives with stochastic volatility

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  • Bomi Kim
  • Jeong-Hoon Kim

Abstract

In this study, we consider short interest rate models of the Vascicek type with stochastic volatility and obtain formulas for default risk in interest rate derivatives. Corrections from a fast mean-reverting stochastic volatility are computed to show how they can affect the term structure of the interest rate derivatives. Our results for the defaultable bonds as well as the corresponding bond options are obtained as an extension of the non-defaultable case studied by Cotton et al. [Math. Finance, 2004, 14(2), 173–200].

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  • Bomi Kim & Jeong-Hoon Kim, 2011. "Default risk in interest rate derivatives with stochastic volatility," Quantitative Finance, Taylor & Francis Journals, vol. 11(12), pages 1837-1845.
    • Handle: RePEc:taf:quantf:v:11:y:2011:i:12:p:1837-1845
    DOI: 10.1080/14697688.2010.543426
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    Cited by:

    1. Cao, Jiling & Lian, Guanghua & Roslan, Teh Raihana Nazirah, 2016. "Pricing variance swaps under stochastic volatility and stochastic interest rate," Applied Mathematics and Computation, Elsevier, vol. 277(C), pages 72-81.

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